How to Draft a Personal Loan Agreement

When you borrow from a bank, credit union, or other personal lender, each has a personal loan agreement prepared. For your own private lending, though, you’ll need to create your own loan document.

Here’s what you need to know about using a personal loan agreement.

What Is a Personal Loan Agreement?

A personal loan agreement is a contract between parties that spells out the details and repayment requirements of a lending arrangement. This process is important for ensuring that all parties understand the amount of money being lent, the terms of repayment (including interest charges and timeline) and potential penalties for default.

When Is It a Good Idea to Have a Personal Loan Agreement?

Anytime money changes hands with the intent that the recipient will pay it back, it’s a good idea to have a personal loan agreement. Even though it might seem counterintuitive to create a loan agreement when lending money to family or friends, it can be a good way to keep everyone on the same page.

It’s easy to forget the terms of a loan when you simply hand over the money and ask for repayment. With a personal lending contract in place, everyone understands the expectations, and all parties can refer to it if there are ever any questions.

What You Need to Draft a Personal Loan Agreement

When creating your personal loan agreement, it’s a good idea to determine what documentation you’ll need. Here are three examples of personal loan agreements and their purposes:

• IOU: This type of agreement is usually provided by the borrower in exchange for a small amount of money. The borrower can sign it, acknowledging the debt. When they repay the debt, the lender can then return the IOU with a note that the debt was repaid. An IOU should only be used for small amounts of money with flexible repayment terms. In general, an IOU should not be used when interest charges and regular payments are expected.
• Promissory note: Another type of flexible repayment arrangement, a promissory note is designed to acknowledge the debt between a borrower and a lender. A promissory note often includes simple terms related to interest charges and might come with a flexible repayment schedule. Small collateral can be used to secure a promissory note.
• Loan contract: A personal loan contract makes sense if you are lending or borrowing a substantial amount of money and have a specific repayment schedule that includes interest charges. This type of personal loan agreement is legally binding and enforceable, and includes specific legal language related to the repayment of the debt.

Once you know the type of loan agreement you’ll use, look for a template to help you correctly structure the agreement. Make sure you print out at least two copies of the agreement or be prepared to make a copy of the signed document. Each signatory should have a copy. You could also consider having a notary witness your signatures, but this isn’t strictly necessary.

Key Features of a Personal Loan Agreement

When preparing a personal loan agreement, you should include some key features:

• Identify the involved parties: Use the legal names of the two people involved, clearly identifying the borrower and the lender, including their Social Security numbers (SSNs). Consider including each party’s address as well.
• Date of the agreement: Include the effective date for the personal loan contract at the beginning of the agreement, then make sure each party dates it at the end of the loan.
• Amount of the loan: Clearly state the amount that the loan is for. This should be the principal amount if interest is included. Not every loan agreement needs to include interest charges.
• Interest rate: If you’re charging interest, state the rate and whether it’s simple or compound. Review federal and state laws around charging interest. A reasonable rate should be charged if the borrower doesn’t want to be subject to gift tax laws and other potential issues.
• Repayment terms: Specify how long the borrower has to repay the loan and whether it will be paid on a regular schedule. You can decide to make the terms pay-on-demand, payment by a certain date, or installments.
• Penalties for default and other issues: Your loan agreement should be clear about recourse in the event that the borrower doesn’t make payments as agreed. This can include a payment penalty for late payments and an affirmation that the borrower will pay court fees and other costs if the loan agreement has to be enforced. Finally, if collateral is included in the loan agreement, state what will be repossessed in the event of default.
• Governing law: Be clear about the state of governance. Each state has its own rules for lending. In many cases, though, it makes sense to abide by the laws in the state where the lender resides.
• Statement of severability: Include a statement that the rest of the agreement will remain in force if a portion of the agreement is deemed unenforceable.
• Statement of entire agreement: Language should be included that the agreement encompasses the entire arrangement and that there aren’t unstated promises. Additionally, this section should make it clear that the arrangement can’t be changed unless all signatories agree.

Legal Implications

It’s important to understand the implications of a personal loan contract. The lender can enforce the terms in court with a signed loan agreement. So, if a borrower doesn’t pay as agreed, it’s possible to go to court and get an order for the borrower to make payments, including liens and garnishments.

Review federal and state requirements for agreements, since the implications can differ depending on the jurisdiction. It’s important to include the statements of governing law, severability, and entire agreement as well. These statements have the legalese that can provide additional protection for both parties, even if a portion of the document is found to be illegal or unenforceable.

Key Terms and Concepts

When creating a personal loan agreement, it’s important to understand the key features of any loan agreement.

• Interest rate and APR: The interest rate is the amount charged as a cost for borrowing money. It can be fixed or variable, simple or compound. For most personal loan agreements between family and friends, sticking to fixed, simple interest likely makes the most sense. The annual percentage rate (APR) includes the interest plus any fees paid for the loan. In many cases, loans between family and friends don’t come with upfront fees, so the interest rate and APR are often the same.
• Payment terms: Loan agreements should be clear about repayment. This includes information about whether the principal and interest must be paid by a certain date or if the lender can demand full repayment at any time. It might make sense to provide regular installment payments to make the process more manageable. The loan agreement should include the amount of the installment, based on the principal and interest, and how long the borrower has to repay the loan.
• Co-signer: If you allow the borrower to get a co-signer, they should be included on the documents. A co-signer agrees to take responsibility for the loan if the original borrower doesn’t meet the terms.
• Collateral: This is something valuable designed to secure the loan. If the borrower agrees to let you have something valuable—such as a car, piece of jewelry, or some other asset—in the event of nonpayment, that should be spelled out clearly in the loan agreement.

Guide to Drafting a Personal Loan Agreement

Consider looking at samples of personal loan agreements, including the one provided by the U.S. Securities and Exchange Commission (SEC). You might also find templates from popular apps like Microsoft Word and Adobe. Companies like DocuSign, PandaDoc, and Oneflow all make it easy to create and sign agreements.

Once you have a template to work with, create your document in the following order, with each item clearly spelled out:

• Date of the contract and effective date of the loan
• State governance for the loan agreement (usually the residence of the lender)
• Identities of the borrower and the lender, often including addresses
• Loan principal amount, without including interest and fees
• Amount of interest charges (if applicable), including the rate and total amount expected to be charged by the time the loan is paid off. Any fees, plus the APR, should also be stated.
• Repayment terms, including whether there are installments (and how often they should be made and in what amount) or whether the entire principal and interest will be paid at once
• Late fees and penalties might be collected if payments are missed. Details about what makes a payment “late” should be included.
• Collateral, and the terms for repossession, if applicable to the loan agreement
• What happens in the event of default
• Whether there’s a co-signer on the loan and when the lender could ask the co-signer to begin taking over the terms of the loan
• Legalese, including language about severability and the entire agreement clause
• Space for the borrower and the lender to sign and date the document
• Space for the notary, if you’re having the document notarized

The Bottom Line

Whether you’re a borrower or a lender, understanding how a personal loan agreement works is crucial for ensuring that the loan terms are favorable to your interests. If you’re a lender, double-check that a personal loan agreement contains all of the necessary clauses and stipulations. If you’re a borrower, be sure to review a personal loan agreement closely to ensure that you know what you’re agreeing to, and consider speaking with a financial advisor if the loan terms are difficult to understand.